Government to Impose Heavy Losses on Shareholders and Bondholders, Hire Advisers to Help Manage Lenders' Assets

MADRID—The Spanish government will impose heavy losses on investors at nationalized banks and hire external advisers to help it manage these banks' assets, its latest efforts to overhaul a financial sector battered by the collapse of a decadelong housing boom.

Forcing shareholders and bondholders to share the cost of restructuring the country's five nationalized banks was a politically costly step for the government of Prime Minister Mariano Rajoy, but one that was required under the terms of a European Union bailout of Spain's ailing lenders. The decision to solicit advice in drafting a long-term strategy for these lenders came after the state-backed Fund for Orderly Bank Restructuring failed to sell one of them, midsize Catalunya Banc SA.

The bailout fund, known as the FROB, has decided to hire consultancy McKinsey Co. and investment bank Nomura International PLC as advisers, say people close to the situation.

Representatives for the FROB and Mckinsey weren't immediately available to comment on the decision. A Nomura spokeswoman declined to comment.

Overhauling the banks is a key part of the government's efforts to turn around an ailing economy, now in its sixth consecutive quarter of recession. Bank credit is shrinking and unemployment has shot past 26%.

The restructuring terms announced by the FROB will impose losses of up to 61% at Spain's largest nationalized banks. At Bankia SA,BKIA-0.41% the largest of the institutions and the only one that is publicly traded, shareholders will be nearly wiped out and junior bondholders will lose around 30% of their original investment.

In keeping with EU requirements that investors bear losses before companies receive state aid, the nominal value of Bankia's shares will be reduced to €0.01 from €2 and the nominal value of its preferred shares and subordinated debt will be reduced to €4.841 billion ($6.29 billion) from €6.911 billion, the bailout fund said.

To recapitalize Bankia, the €4.841 billion worth of preferred shares and subordinated debt will be converted into ordinary shares, while the FROB will inject €10.7 billion. This recapitalization will result in a massive dilution for Bankia's shareholders, who will be left with less than 1% of the bank.

The FROB also said it would reduce the value of preferred shares in other ailing banks—Catalunya Banc's by 61%, Banco Gallego's by 50% and NGC Banco's by 43%—and then convert them into ordinary shares. But as these three banks aren't publicly traded, the Spanish government said it would give the holders of their newly created ordinary shares the option of selling them to the country's deposit guarantee fund.

Last month, the FROB said the preferred shareholders at Banco de Valencia SA, a smaller nationalized bank, faced losses of 90%.

The government had warned that the losses imposed on investors at the nationalized banks would be significant. The FROB had ordered external valuations, which found that their liabilities far exceeded their assets. In Bankia's case, an evaluation found that it had a negative value of €4.15 billion.

Nonetheless, imposing losses on investors is one of the politically difficult steps required of Spain in exchange for just over €40 billion in EU aid because most of those who made investments in the troubled lenders were small depositors.

Many of these small savers have taken to the streets to protest their expected losses in recent months, claiming they were misled into believing that that they were buying low-risk savings products, not risky bonds or shares.

Spain's government for months argued with Brussels, ultimately unsuccessfully, to allow for some flexibility on state-aid rules that require investors share the burden with taxpayers.

Spain then set up an arbitration mechanism by which clients who claim they were misled can have their case reviewed; when such claims are upheld, the sales will be annulled and the clients will recover their initial investment.

This copy is for your personal, non-commercial use only. Distribution and use of this material are governed by our Subscriber Agreement and by copyright law. For non-personal use or to order multiple copies, please contact Dow Jones Reprints at 1-800-843-0008 or visit www.djreprints.com.